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The government is playing a dangerous game. In our society, power rests on belief. In the most basic sense, you vote for the people you want representing you in government. The ones who make laws and rule on your behalf. You vote for them presumably because they represent an alignment with your interests; you "believe" that they will move the country in a direction you think is beneficial and important.
What happens when that belief starts to crumble? What happens when government of, by, and for the people slides into...something else? When the people see institutions of authority as a system rigged against them? The BLM protests last summer (and ongoing) come from that place. So, too, do the election protests. And the lockdown protests that are spreading across Europe and Australia (and coming to the US?). People, understandably, feel a need to take action. To regain some semblance of control. Our largest collective identity - as a nation, under the same institutions of authority - breaks down and identity becomes more fractured; an "us" vs "them" mentality that fractures across any number of ideological fault lines. The more the belief that those in power have the collective good in mind breaks down, the more fractured those identity groups become until, at the extreme, you end up with anarchy. Now, governments everywhere and always tend to play fast and loose with credibility. In our own country, you can easily point to entry into the Vietnam War, Weapons of Mass Destruction in Iraq, or domestic surveillance as examples of blatant government lies. But it feels somehow different when you see it play out in front of you. Day in, day out in realtime.
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A quick prelude before we dive into an economic policy debate on minimum wage:
In monetary news, for a hot second, markets are in the middle of a tiny meltdown over what was perceived as a "more hawkish" Fed after their June meeting this week. What made the Fed more hawkish, you ask? Well, every member is asked, at every meeting, to throw a set of darts at a board. One dart for where they think rates will be at the end of 2021, one for the end of '22, one for '23, and one for "longer term". The median dot for the end of 2023 moved up to 0.625% from 0.125%, implying two rate hikes. Sorry, we meant "two rate hikes!". Note the breathless exclamation point of excitement/concern/alarm. So in the face of continuing supply chain disruptions and mounting (possibly transitory) inflation pressures, the Fed says, on average, we can expect two rates at some point 18-30 months down the road (because note: the median dot for year-end 2022 is still zero). In the meantime, still no taper on COVID-initated QE of $120B per month until "substantial progress is made", so…$120B times 18 months equals….$2T+ of more QE coming into the markets over the next year and a half with no projected rate hikes? BTFD. And pray that the current inflation is actually transitory. Seems a perfectly good reason to slam commodities and precious metals to us! (nb: sarcasm). In fiscal news, there's a looming benefits cliff (again), as the federal unemployment assistance is set to expire (again), this time in early September. If it doesn't get renewed (again). Half the states have already chosen to end the expanded federal unemployment benefits early, based largely on the argument that people are getting paid more (via expanded unemployment benefits) to stay at home rather than go get a job, which is having a negative impact on those states' economies. That argument is not wrong. Look at every single business struggling to hire employees coupled with the 15 million people filing for unemployment benefits. Or, to put a finer point on it, job openings have increased by about 50% since late-December, while over that time period the number of people on pandemic unemployment programs specifically has stayed the same. So yes, it's time to wean off the pandemic unemployment assistance programs before we get saddled with yet another crisis-spawned, perpetually bloated government expenditure program. But it's also time for a $15 minimum wage. Warning: This newsletter will scroll long, because of all the pictures. It's also the most monetarily valuable newsletter we've ever written (it contains about $70M of art), so scroll with care.
Doges were originally the elected leaders of Italian city-states during the Medieval/Renaissance eras. This note is not about them. Being an April newsletter, we're going slightly off the rails here. Not so much into our normal April tinfoil hat conspiracies, but most definitely into market absurdities. This time featuring delis and Shiba Inus.
Travel is back! We were in the Dominican Republic last week, our first international trip since COVID. It was...refreshing, in a lot of ways. The flight out of Logan crack-of-dawn early, so we stayed in an airport hotel the night before. There was a line at check-in, and the parking lot was completely full. Also full - the 4:30am shuttle bus to the airport in the morning. Literally every seat. Not "every available socially-distanced seat", every single seat in the thing. And the airport was the busiest we've seen since the Sunday after Christmas. The line for Cinnabon in BWI was a solid 30 people deep. Also, Terminal A in BWI is now open again, which it wasn't in June, November, December, or January.
Perhaps the most striking thing about the fellow passengers? It wasn't Spring Break week, the airport wasn't packed with families and little kids. It was mostly older folks. A lot of white hair, and way more Columbia, sneakers, and backpacks than Hugo Boss, oxfords, and briefcases. Have vaccine, will travel. (As an aside, to get back into the States from overseas requires either a negative COVID test within 3 days or documentation of a positive test and recovery within the previous 90 days. Even if you've had COVID and recovered, we'd highly recommend going the negative test route. Watching the airline check-in employee try to make sense of a random lab printout and equally non-uniform clearance from a random state health department leaves a lot of room for translational errors. Just go with the standard lab report from their own country's labs that they're used to seeing.) Relatedly, have you noticed how almost every restaurant or retail shop has a 'Now Hiring' sign posted in the window? At least they do up here. It makes us optimistic for what could be a rather booming economic recovery this summer, especially if vaccinations continue apace. Which brings us back to the disconnect between financial markets and the underlying economic reality. The stock market bottomed on March 24th last year and was up around 40% through May while in real life, lockdowns were becoming more draconian and more and more businesses were getting shuttered. We wonder if there will be any symmetry to this coming out the other side - businesses are hiring, travel is coming back, countries are reopening borders, economic activity is picking up...but this has already been effectively "priced in" by the markets. Is there much upside to be captured in stocks from economic growth when that growth merely confirms the underlying assumptions justifying such market levels in the first place? We shall see. What a week! Down with the shorts! David vs Goliath! Occupy Wall Street! Stonks!
The current tagline of r/wallstreetbets is "Like 4Chan found a bloomberg terminal", though for most of Thursday and Friday it actually read "Like 4Chan found a bloomberg terminal illness". Which is both clever and the most accurate description possible. We imagine a lot of people were exposed for the first time last week to some fairly nuanced and advanced financial concepts that got completely mangled in the media because who has time for nuance these days, right? Well, we do! So let's unpack what's going on a bit. You know what a lot of the best surfing spots in the world have in common? A dangerously shallow reef. The reef at Maverick is about 20 feet deep at the break. Pipeline's reef is less than 10 feet from the surface. The reef at Teahupo'o is less than 6 feet deep.  Give a wave a lot of open ocean to conserve energy, then stick a shallow reef with a steep drop-off down to the continental shelf in front of it. The drag caused by the bottom of the wave interacting with the seafloor drives all that wave energy up into a crest and over into a hollow barrel. (Knew that oceanography degree would be good for something!).
How is this relevant to investing, you may ask? Well, despite a false start a couple months ago, the Blue Wave finally materialized this month, and it looks like it's carrying an entire 4-year ocean's worth of fiscal stimulus. The last newsletter of 2020 is brought to you by the less-than-sign. We are, of course, referring to the shape of the economic recovery post-COVID. Earlier in the year, it was posited that the letter V would be the winner, but it turns out V was already spoken for. Ditto L.  W was popular for a hot second amongst the non-V-believers, but at that point you're getting dangerously close to tautology and Elliott Waves, unless you want to get into semantics about whether the middle peak of the W comes up even with the start and end peaks (as with typeface), or gets short-changed a bit (as with handwriting).
As far as letters go, K is now far and away the dominant narrative for economic recovery, despite itself already being spoken for as well. And really, K is a bit of a misnomer, since you can't graph a vertical line (valid functions, people!). But we suppose that "less-than-sign" doesn't have the same easy memefication potential (or strong lobby presence in DC perhaps?) despite being more descriptively accurate, so K wins. For the sake of truth and trying to avoid the memefication curse that is currently plaguing our society, we will make a valiant Alamo-like stand and refer to it as the "less-than-sign" recovery. Which, while a mouthful, is still less burdensome than the also accurate "the-right-side-of-the-letter-K" recovery. In any case, the point is that the economic COVID recovery is completely bifurcated. There's one group of people doing fantastically well, and there's one that is suffering massively. By and large, the upper arm of the less-than-sign was already the "upper" part of society. And the lower arm was already the lower arm. The COVID response has mainly served to exacerbate the already-growing wealth disparity in this country. And for that, you can and should rightly blame the Fed, Congress, and many state governors. Let's recap: The "What Comes Next" title is a reference to one of the songs sung by King George in Hamilton. We can't quite put our finger on it, but it feels like there are certain parallels between Mad King George and our current situation.
What exactly is our current situation? From an S&P 500 standpoint, we're back to where we were at the start of September. These 11 weeks have been far from flat, though. Down 10% over the first three weeks in September, then up 10% over three weeks into October, then down almost 8% in the three weeks leading up to the election, and then up 10% in what can only be described technically as a face-melting rally since the election. To recap: pre-election, there were widespread expectations of a "blue wave", and the market sold off a bit because it didn't like seeing the specter of inflation in all the anticipated government spending that presumably Democratic Executive and Legislative branches would entail. As election results came in and the blue wave never materialized, the market rallied. A Deomcrat presidency with a Republican Senate probably means gridlock in DC and not much in the way of fiscal stimulus. Thus, the burden of economic stimulus continues to fall to monetary policy and the ever-ready dovish accommodation of the Fed. Moar QE, in short. And as we have detailed previously and somewhat exhaustively, QE is good for stock prices. Then Monday morning last week, Pfizer came out with a positive announcement on their vaccine's Phase 3 trial, and the market rips. Small caps up 8%. Airlines up 16%. Cruise lines up 23%. Movie Theaters up 60%. Retail up 24%. Even Hertz (still in bankruptcy, by the way) up 25%. Face melting. As we write this, the market is in the middle of a face-melting rally. And yes, that's the technical term for it. To recap: in the three weeks before the election, the market lost 7.5%. There were widespread expectations of a "blue wave", and the market didn't like seeing the specter of inflation in all the anticipated government spending given Democratic Executive and Legislative branches.
Since election day, the market's up 11%. In a week. Initially, the market rallied on the much ballyhooed "blue wave" not materializing. If there's continued gridlock in DC, then it falls to the Federal Reserve to try and stimulate the economy. Which means more QE. Since all QE really does is drive up stock prices, the market was happy. And then this morning, Pfizer comes out with a positive announcement on their Phase 3 trial, and the market rips. Small caps up 8%. Airlines up 16%. Cruise lines up 23%. Movie Theaters up 60%. Retail up 24%. Even Hertz (still bankrupt, by the way) up 25%. Face melting. The problem here is that nobody really knows anything. Well. The scariest night of the year is almost upon us (take your pick of October 31st or November 3rd), and it definitely feels more trick than treat in the markets this week, doesn't it? Monday was off a couple percent, no bounce on Tuesday, and then down another 3.5% Wednesday. A little bounce yesterday, but all given back again so far today. Frustratingly, Wednesday's selloff was another one of those days where literally everything sold off. Stocks, bonds, gold..everything. To put that into perspective: stocks, bonds, and gold all down on the same day has happened twice. Ever. And both those times were back in March of this year.
Which kind of makes sense...the catalyst for the selloff is a little murky, though it seems like Europe (at least Italy, Spain, France, Germany, UK, Belgium, Czech Republic, and Poland) reinstating various lockdown measures is largely to blame. Domestically, optimism around a fresh stimulus deal seems misplaced (though does that actually surprise anyone a week before the election?), and the election races seem to be tightening. A few weeks ago, the default positioning on elections felt like expectations of a "Blue Wave" result next week, and markets had been rising ahead of an expected proverbial opening of the government spending floodgates. Now, it feels like there is a reconsideration of that outcome. Markets hate uncertainty. The worst possible outcome (for markets) is a contested election that has to spend months working its way through the courts. Tighter polls make that outcome marginally more likely, so perhaps what we're seeing in this selloff a broad deleveraging of risk assets. Or maybe it's the opposite of what we saw back in Q2 and is a bit of a negative gamma squeeze. In the spirit of Halloween, we'll take this newsletter in less of the obvious Bruce Banner/Incredible Hulk direction and more of a The Gamma People/Creature with the Atom Brain direction as we dive into what exactly gamma is and how it moves markets. How much money do you need to be wealthy? According to a poll conducted by Schwab last year, it's about $2.3 million. Unsurprisingly, that number varies depending on the age of the respondent. Gen Z-ers think $1.5 million is wealthy. Millennials think it's $2M, and Gen X and Boomers think it's up over $2.5 million. Interesting that all those numbers are pretty solid anchor points: one-and-a-half, two, two-and-a-half...psychologically speaking, it feels like the survey respondents just picked a random number out of thin air. The pre-k demographic wasn't surveyed, but one can assume their response would be along the lines of "one thousand thousand million hundred thousand and nine". Our answer: it depends.
We're going to open this note with a slight adaptation to the musical stylings of Salt-N-Pepa:
Let's talk about symmetry Let's talk about you and me Let's talk about all the made up Things the Fed has caused to be We are, of course, referring to the Fed's recent "policy decision" from Jackson Hole. (According to Strunk and White's classic Elements of Style (updated and annotated by Robertson), when referring to the Fed, "policy decision" should always be in quotes, to denote its made-up nature). The "policy decision" essentially codified a symmetrical inflation goal. To translate with some background for anyone not fluent in Fed-speak: One of the explicit reasons for being of the Fed is to "maintain price stability" (direct quote quotes, not made-up quotes this time). They used to take that literally and target actual price stability. Then in 2012, there was a new "policy decision" (back to make-believe) that said price stability meant 2% increases in price every year. That doesn't sound particularly stable to us, but the Fed hath spoken and so shall it be. Does Halloween lose a bit of magic because people have been wearing masks for 6 months already? Resoundingly, no. Sure, it may be more trick than treat this year, but Halloween itself is about the atmosphere - shorter days, cooler evenings, foggy mornings, zombies...yes, the zombies. We are in the middle of a zombie apocalypse - you see them every day and probably have no idea until they collapse and die right in front of you. One of the more recent ones to be decapitated and burned (take your pick of favored zombie disposal methods) is...Hertz.
That’s right, we’re talking about zombie companies! Zombie companies are those that should have gone out of business a long time ago, but have been reanimated through the Fed’s zero interest rate policies. Without going on another rant about how the Fed has destroyed the notion of productive capital allocation, here’s how zombie companies form: The upshot of last month's webinar, for those of you that missed it, was that the Fed is turning the stock market into a house of cards, but you might as well make yourself comfortable in it. Recently, we've been having a number of conversations that suggest we need to elucidate that point a little further than can be accomplished in a 40-minute Zoom. So here we go:
What is investing? Are you "investing in companies" when you buy into the stock market? No. 99% of the time you are not investing in a company. The only ways you can actually invest in a company are: public stock offerings (usually IPOs); public debt offerings; private equity or debt deals. Last year, there were a low-200's number of IPOs that raised around $62B total. Through the first half of 2020, there have been 64 IPOs that raised $22.3B. The total value of the US stock market is right around $30T with a "T". So in any given year, about 0.2% of the stock market is actual "I want to invest in your company" money. You've seen a record $1.2T in new bond issuance (more on this in a bit) year-to-date in a $40T bond market. Private markets are up to about $6.5T total and have added $370B or so a year (including performance). So recently, in any given year, you could reasonably expect about $1.6T in real "give this company my money" investment. In a combined stock/bond/private marketplace in the US of $77T or so. That's 2%. Okay, sorry, we were wrong: 98% of the time you are not investing in a company (though really, most of that 2% is limited to a very select few, so in our defense it is likely closer to 99%). So what are you investing in? When you buy your shares of Apple or Tesla or Aurora Cannabis, you aren't giving your money to the company for them to do amazing world-changing things with. You're not giving your money to the company at all. That's why the stock market is a "secondary" market - you're giving it to the person you bought the shares from. |
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